The Telecom Act: A New Day

The Telecommunications Act of 1996 promises to bring about the most profound changes in the US long distance market since the divestiture of AT&T in 1984. The Regional Bell Operating Companies (RBOCs), prohibited by that legislation from offering long distance service, may now enter that market once they've demonstrated that they have comprehensively opened their local networks to competitors. Controversy over interpretation of the Act has already brought court decisions holding off Federal Communications Commission (FCC) rules on local competitive pricing. The result is a rising level of confusion and delays in the RBOCs' provision of long distance service. For example, Ameritech, moving to skirt the current logjam, has re-applied to the FCC for long distance authorization having once had its petition denied, arguing that this time, it has met the Act's 14-point checklist for facilitating long distance competition.

Major issues await resolution before creation of the competitive telecom market envisioned by the Act. Critical to its success are the FCC proceedings on access and universal service, which logically need resolution before full-scale competition can emerge. Major differences over interpretation of the Act pertain to the degree of federal versus state authority. One issue is whether local network elements should be priced only on the ongoing incremental costs of providing service, or also on the long-term embedded investments in LEC networks. A second issue concerns the joint marketing of local and long distance service.

The international long distance market is also changing in important ways that are quite separate from any effects that the Act might occasion. The FCC is seeking to change the long-standing international settlement rate system. The current system results in a $5 billion deficit, when comparing US carriers' receipts from international calling against US callers' payouts for such service. Moreover, international rates will decline significantly with expanded transmission capacity and liberalized regulation.

Market Forecasts

For the purposes of this report, our definition of the long distance market includes interLATA calling, intraLATA toll calling, plus international revenues received by US carriers on international calls. Our analysis began by modeling total LD growth assuming no effects created by the Act. Were the Act not passed, we projeceted the total US market for long distance services would grow from $92 billion in 1997 to $103 billion by the year 2002.

As a result of the Access Charge Reform Order 97-158 issued May 7, 1997, the FCC expects to see domestic long distance revenues fall off by at least $20.5 billion over the five and one half years. Our analysis took into account the effects of lower access charges created by the Order, as well as the elasticity effect that lower prices would have on stimulating additional long distance calling.

In our analyis we also included the international revenues billed to US-based end-users (which includes those who use "dial-back" cards and services from abroad to make calls billed as US-outbound calls though they are at the time located elsewhere), rather than in revenues retained by US-based carriers.

We feel that any forward-looking analysis of the LD market should include both of these major effects to carrier revenue.

The Analysis

Insight's analysis suggests that gains by the RBOC in the interLATA and international markets will not be offset by IXC gains from intraLATA tolls--to the point that the IXCs in the aggregate will experience overall negative growth in the forecast period if we exclude growth from international traffic. However, offsetting the RBOCs' interLATA revenue growth will be corresponding loss of switched access revenue, intraLATA revenue, and a need to resell long distance out-of-region using IXC circuits.

International calling will prove the strongest long distance market growth, with double-digit revenue growth slowing to single-digits by late in the forecast period. In terms of services offered, toll-free calling will lead in market growth, followed by dedicated services, business outbound calling, and residential calling.

While the RBOCs can expect to enjoy opportunities in long distance, they also face corresponding threats to their intraLATA toll and switched access businesses. To meet this challenge, the RBOCs will generally emphasize in their long distance strategies such qualities as price simplicity, trust, positive customer ID, while they put their considerable marketing muscle behind the underserved small business and residential segments. Each RBOC's past marketing success is probably the best indicator of future success, and those with strong regional identities will be well positioned.

The IXCs have already leveraged their crucial timing advantages to define the market and to take the competitive lead. They are preemptively beginning to bundle services for a one-stop shop, simplifying and in some cases lowering their prices. In addition, they are gradually taking their end-user billing business back from the LECs, and skirting prohibitions found in the Act against joint marketing of resold local and long distance services.

In the face of the IXC's early advantage, the RBOCs will have to consider substantial price drops to make buyers shift to the RBOC brand. The RBOC dilemma is that they are not ready for the profit stress that a real price war with the IXCs would require; although the SBC-Pacific Telesis and Bell Atlantic-NYNEX mergers came about, in part, to better prepare for that possibility.

Meanwhile, all the RBOCs are seeking to establish their new long distance affiliates with cultures distinct from those of the larger organization. Many have staffed their new long distance organizations with personnel experienced in the competitive long distance market. The provisions of the Act for separate affiliates are a major headache for RBOCs to interpret and live by. However, they have the positive effect of giving the new organizations a fresher start than would otherwise have been possible.

While there is more market interest at this point in changing LECs than in changing IXCs, and while the latter clearly have the timing initiative, the LECs still have a few trumps to play. For example, the LECs have excellent terms for resale in the long distance market, and they enjoy the logistical ease of starting out as long distance resellers. In contrast, the IXCs face
corresponding logistical difficulties, such as interconnection, while establishing themselves in the far more complex and expensive
local business market.

While our investigation showed that the RBOCs have broadly similar strategies, each is different in several particulars. The differences include the share of their business in toll, the volume of potential long distance originating in their regions, and the distribution of it in terms of intraLATA and intrastate geography. The latter is crucial when calculating the extent to which their expanding opportunities threaten their current business. Carriers with a large intraLATA base, such as Pacific Telesis, face a strong
risk as IXCs could gain large new volumes at their expense, and undoutedly was a major factor prompting the company's sale to
SBC.

In the end those RBOCs that are slow to open up their local networks and gain FCC approvals will be slow to get into long distance. An early market presence is important, since customers who have changed providers will be less likely to switch again. RBOCs' strategies differ in the degree to which they value retaining what they have as a means to slow the onset of local competition, versus seeking new revenue from long distance. Because competition is inevitable, and because the IXCs will increasingly be able to offer local and long distance one way or the other, those RBOCs that get into long distance quickly will have advantages.

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